Railroaded

Lies, Damn Lies, and Statistics:  Last week’s employment data might fall into that category. There was an uncharacteristic increase of 325K to nonfarm payrolls when adding revisions from prior months, Employment in food and beverage service was 69K, five times its average over the last year.  The reports just don’t look right, but if these above trend numbers are correct, then the Fed has to pause rate reduction. That is exactly what the bond market is betting, as the 10yr moved back to 4% in very short order. We need to see more corroboration in the coming data to see if this is just an anomaly, or that the economy is still very strong and inflation worries are back on the table.

German Choo Choo

Until recently, Germany was considered the great locomotive of Europe. However, the economy has stopped dead in its tracks, with Chinese competition driving down demand for German manufactured goods globally. Meanwhile, the German DAX equity index closed near the new highs from a week ago on hopes for deeper rounds of interest rate cuts from the ECB. The stock market is ignoring negative business confidence and sharply rising unemployment. Germany’s labor market may be much more important than the U.S.’s for the future direction of the global economy.

Germany’s September Purchasing Manager’s Index (PMI) came in last week at 40, the lowest level in a year, with sharply declining New Orders. Employment fell at the fastest pace in four years during September. Analysts said that the Employment component is the equivalent to a negative U.S. Nonfarm Payrolls print of -100,000. Inventory destocking has gone on for an impossibly long 18 months, so each month's expectation is for a rebound in production to mark an upturn in the inventory cycle. However, pessimism from persistently weak demand pushed input stocks down again, registering the largest drop since 2009.     

France’s Emmanuel Macron warns that Europe’s growth model is at risk. While the European Central Bank (ECB) had ruled out an October rate cut due to sticky services inflation, ECB Board Member Olli Rehn said after the PMI data that there is justification for an October rate cut. UBS expects cuts in the next four meetings in October, December, January, and March. The prospect of ECB action makes Germany’s stock market the most interesting to watch, to see whether a stream of rate cuts can drown out the deteriorating economic decline. If Germany avoids a strong equity selloff, a consensus will form that if monetary easing can solve Germany’s problems, all global equity markets can extend to new heights. We are quite amazed at the resilience of the DAX in the face of an impending recession, but we felt the same way in October 2007 about U.S. stocks.

Yin & Yang of China Stimulus

There are opposing forces at play when considering how effective China’s stimulus will be. The positive stimulus package was rolled out during the September monthly Politburo meeting. That was unusual because economic matters are normally discussed in October’s meeting. That revealed a sense of urgency and was choreographed to coincide with the quarterly People’s Bank of China (PBoC) meeting. The Politburo emphasized the need to increase the “intensity of fiscal policy” and stated that the reserve requirement ratio and interest rates should be lowered “in a powerful manner.” The PBoC reinforced this message, declaring that the regulation of monetary policies should be “more intense and more targeted.” These coordinated measures will hopefully be followed by an additional RMB2 trillion supplemental budget later this month.

The great wall in China is the lack of credit demand, aggravated by restrictive real interest rates. Until the country can emerge from deflation, real rates will stay impossibly high, even if the PBoC cuts. The only way credit demand revives is if property values stabilize. Until that occurs, a flood of credit will not be used to buy real estate. Local governments already have incentives to buy unsold homes, but without fiscal support, they have hesitated. There is every reason to believe that without fiscal incentives, local governments will not step up to stabilize the market.

To make matters worse, a stronger Yuan caps imported inflation and exceptionally high unemployment over the last few months have pushed wage inflation in the wrong direction.  

One reason for their sense of urgency may be the need to step in front of future tariff headwinds. Almost 2/3rds of Chinese exports carry an average tariff of 17%. The tariff rate could triple over the next year, and the number of targeted exports is sure to expand. Europe is a major import destination, and as noted above, Germany is leading the Continent into a recession and leading the fight for high tariffs. With the U.S. certainly not backing down on tariffs, let’s hope this is not a case of Beijing doing too little too late.

Fourth and 25

It’s rare for an economist to throw a flag. But that is what happened at Pantheon Macroeconomics Friday morning after the strong September Nonfarm Payroll release. They objected to what they thought was a misleadingly strong 254,000 print. That number not only beat estimates of 150,000, but it was a big jump compared to August’s upwardly revised 159,000. They complained that the September number "goes against the grain of a wide range of indicators pointing to a continued pullback in hiring." They believe the number will be revised down in October. The problem stems from a paltry 62% of the businesses responding on time. Pantheon’s point is valid in that small businesses are often late in responding, and they have been reducing their workforce faster than large businesses. The final number is lower when the Bureau of Labor Statistics finally collects all the data from the small business laggards. The problem with Pantheon’s objection this month is that both July and August were revised up, not down.

If Pantheon is wrong, and the September data is not revised down next month, and October also comes in strong, then the Fed has backed itself into a corner. The October employment number is reported just a few days before the Federal Open Market Committee (FOMC) meets on November 6-7. When they cut 50 basis points in September, the FOMC forecasted rate cuts in November and December, followed by four more rate cuts in 2025. Their plan was to put a floor under sagging employment demand. If employment is about to start an upward trajectory, they may have unnecessarily set the seeds for higher inflation. If that happens, then the fixed income and equity market will start throwing flags of their own.

What to Look for This Week

1. Tuesday, October 8 at 2:00 p.m. E.D.T. FOMC Minutes for the September 17-18 meeting. There has been much discussion about how the job growth and price stability mandates are now in balance, but the Summary of Economic Projections shows no fear of upside inflation risks and a dramatic swing to concern over upside risks to the unemployment rate. We will look for confirming signals.

2. Thursday, October 10 at 8:30 a.m. E.D.T. September Consumer Price Index (CPI) data is released. The last three releases of core CPI have been 3.27%, 3.21%, and August’s 3.26%, so we will see if September continues to thread the needle. If inflation picks up after the strong payroll data, the market might start to price out rate cuts even for this year. Friday, October 11 at 8:30 a.m., E.D.T. follows up CPI with the September data for the Producer Price Index.

3. Tuesday, October 8 at 6:00 a.m. E.D.T. September’s National Federation of Independent Business Survey is broadcast. Our focus will be on the answers to the earnings higher vs. lower over the past three months because August’s figure fell below the pandemic lows, and recalls the levels during the 2008 Global Financial Crisis. That is problematic with stocks at all-time highs, although we need to remember that this is a small business survey.

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